5 Better Reasons to Sell Buffett

Scandal, shmandal. The bigger issue with Berkshire is performance.

By

JackHough

Warren Buffett isn't often called names like "hypocrite" and "gnome" in the press. The public's recent fury relates to David Sokol, one of Buffett's lieutenants at
BRK.A, -0.58%
who resigned abruptly on March 30. As Buffett explained in a letter, Sokol pitched him in mid-January on the idea of acquiring chemical maker Lubrizol, disclosing at the time that he owned shares, but after Berkshire agreed to a deal in mid-March, Buffett learned that Sokol had bought his shares just weeks before his pitch.

Sokol made around $3 million in two months on his $10 million purchase. At worst, he had reason to know his recommendation would end in a deal (something Buffett denies), which could meet the definition of insider trading. At best, Sokol bought shares because he saw the company as undervalued and mentioned as much to Buffett, who bought the company so quickly that Sokol came out looking suspicious, leaving one or both of the two guilty only of failing to consider the appearance of impropriety.

For all the hand-wringing and name-calling, there seems little about this affair that threatens Berkshire's profits. Investors should sell their shares just the same, for reasons have nothing to do with Sokol or Lubrizol. Here are five.

1. The merchandise seems fully priced.

Berkshire Hathaway has grown the accounting value of its assets by 20% per year since 1965—more than double the rate of return for the S&P 500 index of U.S. stocks. At the end of 2010, class-A shares of Berkshire represented underlying assets worth just over $95,000 per share, according to the company's accountants. But investors who buy today won't pay $95,000 per share. They'll pay more than $124,000. That's because Berkshire isn't priced like a mutual fund, where the share price reflects the value of the underlying assets. It sells for whatever investors are willing to pay. Some of Berkshire's holdings are wholly owned companies and investors can't get exposure to them anywhere else. But many are ordinary stocks like
KO, -0.65%
and
AXP, -0.39%
that investors can simply buy on their own without paying the mark-up.

2. Popularity attracts contempt.

Berkshire's annual meetings, called "Woodstock for Capitalists" and attended by more than 30,000 shareholder-fans, show that Buffett has achieved a level of popularity unmatched in American business today. Sure, Steve Jobs draws crowds, but they're mostly cheering for
AAPL, -0.04%
gadgets. Buffet's followers aren't expressing their love of Geico insurance, See's Candies or other Berkshire holdings; they're celebrating the man. Ask Tiger Woods about the crowd's willingness to forgive when an extremely popular figure stumbles. If Berkshire's premium price is owed in part to Buffett's popularity, and if Buffett's beloved status leaves him with little popularity left to gain, the shares might have limited upside.

3. Berkshire is too big.

Berkshire's asset growth has lagged behind the broad market's return in four of the past eight years. That's as many years of underperformance as the company produced over the prior 37 years. In some ways Buffett's job has become easier over the years; it's nice for an investor to know that a stock will jump when word gets out that he's buying it, and it's helpful for a takeover specialist to have targets volunteer themselves because of his reputation for hands-off management. But Berkshire's size forces it to either increase its number of positions, which dilutes the influence of winners on returns, or to focus positions on large companies, which tend to grow slower than small companies over long time periods. That's not to say Buffett won't do a masterful job given his constraints. It's to say he has constraints.

4. 80 is the new 80.

Here's wishing the man another 20 years at the helm of Berkshire. Here's also acknowledging that it's unlikely.

5. He says so.

"The bountiful years, we want to emphasize, will never return," wrote Buffett in his most recent yearly letter to shareholders. "The huge sums of capital we currently manage eliminate any chance of exceptional performance." There's modestly and there's honesty. That seems like the latter.

Later in the letter, Buffett says he's nonetheless prepared for the challenge. "Our elephant gun has been reloaded, and my trigger finger is itchy," he wrote.

In light of the Lubrizol flub, maybe that trigger finger should turn on the safety.

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